Taking Down Exposure Into Overbought Strength

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Good Morning, this is Capital Essence’s Market Outlook (the technical analysis of financial markets) for Monday December 7, 2020.

We’ve noted in the previous Market Outlook that: “while overbought conditions have returned on a daily basis, the overall technical backdrop remains supportive so downside risk could be limited. It is possible that S&P could continue to drift higher as trading sentiment remains strong.”  As anticipated, S&P rose to record levels on Friday, gained 0.9 percent to 3,699.12, notching another weekly advance, as traders shook off a disappointing U.S. jobs report.  The Dow Jones Industrial Average added 0.8 percent to 30,218.26.  The Nasdaq Composite advanced 0.7 percent to 12,464.23.  The CBOE Volatility Index (VIX), widely considered the best gauge of fear in the market, fell more than 2 percent to 20.79.

Energy stocks jumped more than 5 percent after OPEC and Russia agreed to raise production by 500,000 barrels per day from January, sending oil prices up more than 1% as investors bet on further tapering of production cuts ahead.  Occidental Petroleum (OXY), EOG Resources (EOG), and Diamondback Energy Inc. (FANG) were among the biggest gainers, with the latter up about 13 percent.  As such, the Energy Select Sector SPDR ETF (XLE) jumped 5.45 percent on the day but is down more than 32 percent YTD, underperformed the S&P.  Now the question is what’s next?  Below is an update look at a trade in XLE.

The graphics below are from our “U.S. Market Trading Map”, show the near-term technical bias and trading ranges.  As shown, the underlying is in a short-term bullish trend when the price bars are painted in green.  The underlying is in a short-term bearish trend when the price bars are painted in red.  The yellow bars identify period of neutral or sideways trading pattern.  Additionally, the light-blue shading represents the short-term trading range.  A move above or below that range is considered overbought (as represents by the red shading) or oversold (as represents by the dark-green shading).  Readings above or below the red and green shaded areas are considered extremely overbought or extremely oversold.

Chart 1.1 – Energy Select Sector SPDR ETF (weekly)

Our “U.S. Market Trading Map” painted XLE bars in green (buy) – see area ‘A’ in the chart. XLE has been on a tear in recent weeks after the early June downswing found support near the prior low set earlier this year. The early November rally pushed the ETF above the one-year moving average, a key technical level based on moving averages, signify a bullish breakout and upside reversal.  Last week’s upside follow-through confirmed the bullish signal.  The overall technical backdrop remains supportive of further advance.  XLE has resistance near 45, or the June high and the 38.2% Fibonacci retracement.  Above it, a more significant resistance lies at the 50 zone, or the early 2020 breakdown point and the 50% Fibonacci retracement.

The November rising trend line, just below 33, represents the logical level to measure risk against.  All bets are off should XLE close below that level.

Chart 1.2 – S&P 500 index (daily)

Short-term technical outlook remains bullish (buy).  Last changed November 24, 2020 from bearish (sell) – (see area ‘A’ in the chart).

[Note: for more details analysis, please take a look at our “US Market ETF Trading Map”]

Once again, S&P moved up to test resistance at the lower boundary of the red band.  That level roughly corresponds with the important sentiment 3700 mark.  Money Flow measure trended higher from above the zero line. However, let’s noticed that the indicator is at the lowest level going back to early September, indicating a lack of commitment among the bulls.

Right now, the most important thing watch is trading behavior as the lower boundary of the red band is tested as resistance. As mentioned, a trade above that level indicated extreme overbought conditions. The normal behavior for the S&P has been to consolidate and retreated almost every time it traded above that level so there is a high probability that a significant consolidation pattern will again develop in this area.

On the downside, there is a strong band of support between 3664 and 3600.  A failure to hold above 3600 indicated that long-term buying pressure has been exhausted and a much deeper pullback should be expected and we’re looking at 3484, based on the trend channel moving average.

Short-term trading range: 3600 to 3700.  S&P has support near 3664.  A failure to hold above that level has measured move to around 3600.  Resistance is around 3700.  A sustain advance above that level has measured move to around 3800.

Long-term trading range: 3200 to 3800.  S&P has support near 3200.  A failure to hold above that level has measured move to 2600.  The index has resistance near 3800.  A close above that level has measured move to 4100.

In summary, the fact that buying enthusiasm faded as the S&P rose to new highs does not favor a sustain break to the upside.  With this in mind we’d consider taking down exposure into overbought strength.


Thanks and happy trading.

(By:Michelle Mai for Capital Essence)

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